I receive a private defined benefit pension. About two-thirds of my benefits accrued before April 1997.
The fund’s rules for pension accruals prior to 1997 do not provide for increases in excess of any Guaranteed Minimum Pension. Increases may be provided at the discretion of the company.
However, the company recently reported that no increase would be made this year. In fact, no discretionary increase has been made since 2009.
Pension Benefits: My former employer has not made a discretionary increase in payments since 2009
I am obviously concerned that over time the value of my pension will decrease significantly in real terms due to inflation.
Is there anything I can do other than hope that my former employer feels some moral obligation to increase the pension to account for inflation?
Also, for purposes of calculating the lifetime benefit, is it correct that all defined benefit plans are valued on the same basis, regardless of whether the inflationary increases are discretionary, guaranteed, or limited?
I exceeded my Lifetime Allowance and was therefore hit with a punitive tax. However, my defined benefit plan, which has no guaranteed inflation boost, is clearly worth less than one that is protected to some extent against inflation.
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Steve Webb replies: With prices rising rapidly, it’s obviously important to understand how well your pension will be protected against inflation.
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For old-style defined benefit pensions like yours, there are three different forms of inflation protection to consider:
– Legal protection against inflation, which is guaranteed by law;
– Protection against inflation under the rules of the scheme, beyond any legal minimum;
– So-called ‘discretionary’ increases that the plan does not have to pay you but may decide to pay you.
Legal protection against inflation is through a process known as ‘limited price indexation’.
For service in the regime from 1997 to 2005, the regime is legally required to provide inflation protection up to a limit of 5 percent and for service from 2005 the limit is 2.5 percent.
For these purposes, inflation is now measured using the Consumer Price Index (CPI) measure of inflation.
The second element of legal protection against inflation is when your company pension was ‘contracted out’ of the state income-related pension plan (SERPS).
For service until 1997, instead of your SERPS pension, the regime has to provide you with a Guaranteed Minimum Pension. For GMP accumulated between 1988 and 1997, this has to be indexed for inflation, capped at 3 percent.
Moving on to increases in line with plan rules next, some pension plans have rules that require them to pay increases for inflation that are more generous than those required by law.
An example would be where scheme rules require annual increases to be linked to the Retail Price Index (RPI) measure of inflation rather than the currently much lower CPI measure.
Another example would be where the scheme rules provide inflation protection for all services and not just services since 1997.
STEVE WEBB ANSWERS YOUR PENSION QUESTIONS
Due to the limited nature of the inflation protection provided by law, and sometimes the limited protection provided by regime rules, attention is now likely to focus on the third category of protection: ‘discretionary’ increases. .
These are increases that the scheme is not required to pay under the law or the rules of the scheme, but which they can choose to pay in any case.
In many cases, this would be left to the discretion of the trustees, although in your case it appears that the rules specify that these increases are left to the discretion of the employer.
At this stage, it’s hard to know whether many (or even some) defined benefit pension plans will pay larger increases to reflect higher inflation.
It is probably fair to assume that defined benefit schemes that are currently poorly funded and may struggle even to fund existing pension promises are highly unlikely to pay discretionary increases in addition.
But well-funded schemes, perhaps supported by a committed employer, may choose to do so.
Ultimately, this will be a decision for the plan, and you can always contact them to let them know what a difference a higher increase would make.
But if they refuse to pay discretionary raises, it’s unlikely you’ll be able to do anything, as long as they’ve followed the rules correctly.
Finally coming back to your other question, it’s about how defined benefit pension rights compare to the LTA when it comes to pension tax relief.
The LTA is a measure that tries to put an overall cap on the amount of pension tax relief that people can enjoy, and it is currently £1,073,100.
The amount of your LTA that is consumed in your defined benefit pension is (in simple terms) 20 times your pension at retirement plus any lump sum you withdraw.
As you have noticed, this rule is quite unfair. You could have two pension plans that pay identical pensions at retirement, but one of which offers a much more generous indexation in retirement.
The pension with the best indexation is clearly more valuable but both ‘eat’ exactly the same amount of the LTA.
I suspect that HMRC decided that it was simply too complex to try to value the future stream of pension payments and that a ‘twenty times’ rule was a rough way of testing defined benefit rights against the lifetime allowance.
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Former Pensions Minister Steve Webb is Uncle Agony from This Is Money.
He’s ready to answer your questions, whether you’re still saving, in the process of quitting work, or juggling finances in retirement.
Steve left the Department for Work and Pensions after the May 2015 election. He is now a partner in actuary and consulting firm Lane Clark & Peacock.
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SteveWe get a lot of questions about state pension provisions and COPE, the outsourced pension equivalent. If you write to Steve about this topic, he answers a typical question from a reader here. It includes links to several of Steve’s earlier columns on state pension forecasting and outsourcing, which may be helpful.
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